The Real Difference Between Expenses and Cost of Goods Sold

Having your costs properly allocated is essential so that you can understand what is going on in the business. Especially if profit is too low, the cost separation will allow you to see where the problem is occurring. A pure services business does not have any physical inventory or products that are sold. They will rather account for the cost of services provided to the customer. In simplest terms, the Cost of goods sold includes producing, purchasing, or acquiring the inventory that is sold by a business entity, either manufacturing or merchandising.

  • The purchase of a capital asset such as a building or equipment is not an expense.
  • When you describe monthly living expenses, expenses is more idiomatic than cost as it could be monetized (almost exactly per month).
  • To be deductible, they must be “ordinary and necessary” to the business.
  • When running a business, you must purchase/acquire assets and spend money to maintain those assets to generate revenue.

Once approved, the bills for operating expenses are paid regularly, sometimes through an automated process. Non-operating expenses are separate from operating expenses from an accounting perspective so as to be able to determine how much a company earns from its core activities. A company’s property insurance bill for the next six months of insurance shows a cost of $6,000. Initially the cost of $6,000 is reported as the current asset Prepaid Insurance (or Prepaid Expense) since the cost has not been used up (has not expired). Gross margin is the difference between revenue and cost of goods sold, or COGS, divided by revenue, expressed as a percentage.

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Expenses can also be categorized as operating and non-operating expenses. The former are the expenses directly related to operating the company, and the latter is indirectly related. The matching principle guides the recognition of expenses in the income statement, accounting for the cost on the balance sheet as an expense. According to this principle, expenses are recognized proportionately during the same period in which they are utilized for generating revenue. For instance, if you purchase a car for $20,000, it will eventually be expensed through depreciation over several years. So here, the initial amount you spend to buy the car is a cost, and depreciation, which will occur for the next several years, are expenses for handling that car.

  • Bookkeepers and accountants are responsible for recording all the major and minor expenses that a business entity incurs.
  • Employee wages, advertising, rent, utilities, taxes, and supplies are all examples of expenses.
  • These are the expenses that are incurred from normal, day-to-day activities.
  • Businesses are allowed to deduct certain expenses from taxes to help alleviate the tax burden and bulk up profits.

(One refers to claiming tax deductions as business expenses, not business costs.) So I’d go with expense. Once again, costs are defined in terms of expenditures, which are close enough kin to expenses in my book. A cost is defined as “the benefits given up to acquire goods and services.” An expense is defined as a cost that has been expired.

“Cost” vs “expense” — a usage question

Another example of a cost is an insurance prepayment of $1200 for the next 12 months. This will be recorded in the balance sheet as a prepaid expense, cause marketing meaning which is a current asset. You will divide the insurance payment, paid in advance, evenly over 12 months as an insurance expense of $100 per month.

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However, they are sub-categorized as direct, indirect, general, and non-cash expenses. Examples of expenses include rent, utilities, wages, salaries, maintenance, depreciation, insurance, and the cost of goods sold. Expenses are usually recurring payments needed to operate a business.

Example of Operating Expenses & COGS

Generally, it is calculated as the selling price of an item, less the cost of goods sold (production or acquisition costs, essentially). The words cost and expense are synonyms, but phrases like can be a big expense are normally used in the narrow sense of the amount of money to be spent. The parallel construction can be a big cost, however, is commonly construed more broadly to include negative impacts to reputation, time, relationships, etc. (as well as money). In a nutshell, an expense represents that portion of the acquisition cost of goods or services, which have been expired, consumed, or utilized in connection with the realization of revenue. Assume that a company purchases a delivery truck to be used in its business.

Initially the truck’s cost will be recorded in the asset account Delivery Truck. However, the truck’s cost will become Depreciation Expense as the truck is “used up” in the company’s revenue-generating activities. However, we use the term cost to mean the amount spent to purchase an item, a service, etc. Some costs are not expenses (cost of land), some costs will become expenses (cost of a new delivery van), and some costs become expenses immediately (airing a television advertisement). The accounting treatment of both expenses differs so that a separate statement for costs of goods sold is prepared in the company’s accounts.

If it’s a piece of factory machinery, the units-of-production method may be more appropriate. Expense is a cost whose utility has been used up; it has been consumed. In the second case, converting from an asset to an expense is achieved with a debit to the cost of goods sold and a credit to the inventory account.